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SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

x

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended: March 31, 2003

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.

For the transition period from ___________ to ____________

Commission File Number 1-10031

NOBEL LEARNING COMMUNITIES, INC.

(Exact name of registrant as specified in its charter)

(484) 947-2000
(Registrant’s telephone number, including area code)

Indicate by check whether the registrant (1) has filed all report(s) required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes x No o

APPLICABLE ONLY TO CORPORATE ISSUERS:

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: 6,554,966 shares of Common Stock outstanding at May 12, 2003.

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INDEX TO FORM 10-Q

Nobel Learning Communities, Inc.

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PART I

Financial Information

Recent Developments

Nobel Learning Communities, Inc. (“NLCI” or “the Company”) entered into an Agreement and Plan of Merger, dated as of August 5, 2002, with Socrates Acquisition Corporation (“Socrates”), a corporation formed by Gryphon Partners II, L.P. and Cadigan Investment Partners, Inc. That Agreement and Plan of Merger (as amended by a First Amendment thereto, dated as of October 2, 2002, the “Merger Agreement”) contemplated that Socrates would be merged into NLCI, with NLCI as the surviving corporation (the “Merger”).

Under the Merger Agreement, Socrates’ obligation to consummate the Merger was subject to its ability to obtain financing. Although at the time the Merger Agreement was signed, Socrates had received signed commitment letters providing for the necessary debt and equity financing, subject to certain conditions, Socrates did not receive the financing necessary to consummate the Merger. Accordingly, the Company terminated the Merger Agreement, in accordance with its terms, on February 3, 2003.

“Safe Harbor” Statement under Private Securities Litigation Reform Act of 1995

Certain statements set forth in this Quarterly Report on Form 10-Q constitute “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. These statements include, without limitation, the Company’s outlook for the fiscal year ended June 30, 2003 (“Fiscal 2003”), other statements in this report other than historical facts relating to the financial conditions, results of operations, plans, objectives, future performance and business of the Company. In addition, words such as “believes,” “anticipates,” “expects,” “intends,” “estimates,” and similar expressions are intended to identify forward-looking statements, but are not the exclusive means of identifying such statements. Such statements are based on management’s currently available operating budgets and forecasts, which are based upon detailed assumptions about many important factors such as market demand, market conditions and competitive activities. While the Company believes that its assumptions are reasonable, readers are cautioned that there are inherent difficulties in predicting the impact of certain factors, especially those affecting the acceptance of the Company’s newly developed schools and businesses and performance of recently acquired businesses, which could cause actual results to differ materially from predicted results. Readers are cautioned that the forward-looking statements reflect management’s analysis only as of the date hereof, and the Company assumes no obligation to update these statements. Actual future results, events and trends may differ materially from those expressed in or implied by such statements depending on a variety of factors set forth throughout this Quarterly Report on Form 10-Q.

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Nobel Learning Communities, Inc. and Subsidiaries
Consolidated Balance Sheets
(Dollars in thousands)

The accompanying notes and the notes in the financial statements included in the Registrant’s Annual Report on Form 10-K (as amended by Amendment No. 1 on From 10-KA) are an integral part of these financial statements.

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Nobel Learning Communities Inc. and Subsidiaries
Consolidated Statements Of Operations
(Dollars in thousands except per share amounts)
(unaudited)

The accompanying notes and the notes in the financial statements included in the Registrant’s Annual Report on Form 10-K (as amended by Amendment No. 1 on Form 10-K/A) are an integral part of these financial statements.

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Nobel Learning Communities, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
for the nine months ended March 31, 2003 and 2002
(Dollars in thousands)
(unaudited)

The accompanying notes and the notes in the financial statements included in the Registrant’s Annual Report on Form 10-K (as amended by Amendment No. 1 on Form 10-K/A) are an integral part of these financial statements.

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Nobel Learning Communities, Inc. and Subsidiaries
Consolidated Statements of Stockholders’ Equity and Comprehensive Loss
For the Nine Months Ended March 31, 2003
(Dollars in thousands except share data)
(Unaudited)

The accompanying notes and the notes to the financial statements included in the Registrant’s Annual Report on Form 10-K (as amended by Amendment No. 1 on Form 10-K/A) are an integral part of these financial statements

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NOBEL LEARNING COMMUNITIES, INC. AND SUBSIDIARIES
Notes to Consolidated Interim Financial Statements
for the nine months ended March 31, 2003 and 2002
(unaudited)

Note 1 – Basis of Presentation

The consolidated financial statements have been prepared by the Company pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”) and, in the opinion of management, include all adjustments, consisting of normal recurring adjustments, necessary to present fairly the Company’s financial position and results of operations. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such SEC rules and regulations. It is suggested that these financial statements be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K (as amended by Amendment No. 1 on Form 10-K/A) for the year ended June 30, 2002.

Due to the inherent seasonal nature of the education and child care businesses, annualization of amounts in these interim financial statements may not be indicative of the actual operating results for the full year.

Future results of operations of the Company involve a number of risks and uncertainties. Factors that could affect future operating results and cause actual results to vary materially from historical results include, but are not limited to, consumer acceptance of the Company’s business strategy with respect to expansion into new and existing markets, the Company’s debt and related financial covenants, difficulties in managing the Company’s growth including attracting and retaining qualified personnel and additional enrollments, impairment, if any, of goodwill, increased competition, changes in government policy and regulation, ability to obtain additional capital required to implement fully the Company’s business plan, and the Company’s investment in Total Education Solutions, Inc.

Certain prior period amounts have been reclassified to conform to the current period’s presentation.

Note 2 – Liquidity

The Company terminated the Merger Agreement with Socrates on February 3, 2003. For the nine months ended on March 31, 2003, the Company expensed approximately $1,018,000 of legal, professional and other registration fees and expenses associated with this transaction. These charges, coupled with the overall impact of general economic conditions on the Company’s revenues have placed the Company in noncompliance with certain of its senior debt facility financial covenants as of the quarter ended December 31, 2002 and March 31, 2003. Further, in the absence of restructuring or waiver of these covenants, it is probable that the Company will be in noncompliance of one or more financial covenants for the quarter and year ended June 30, 2003. As a result, the Company has classified all of its senior debt as a current liability at March 31, 2003. The Company has requested a waiver for the covenant noncompliance through March 31, 2003 and is actively engaged in discussions with its senior lenders with respect to amending the financial covenants for future periods. However, management has not received a waiver and is unable to assure that its efforts in this regard will be successful. As a result of the event of default, the senior bank debt can be deemed to be immediately due and payable at the lender’s discretion.

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The Company has $10,124,000 outstanding under subordinated debt agreements at March 31, 2003. The Company is in compliance with the financial ratios of these agreements as they are less restrictive than the senior debt facility. The Company’s subordinated debt obligations maturing after March 31, 2004 are classified as long-term debt.

Note 3 – Merger Agreement

On May 16, 2000, the Company entered into a rights agreement (the “Stockholder Rights Agreement”) with Stocktrans, Inc., as rights agent, under which preferred stock purchase rights were distributed to NLCI’s stockholders. The Stockholder Rights Agreement was amended, on August 4, 2002, by Amendment No.1, to permit discussions among Socrates and management in connection with the Merger Agreement without raising a concern about triggering the rights. In addition, the Stockholder Rights Agreement was amended, on August 5, 2002, by Amendment No.2, to amend the definition of “Acquiring Person,” so that the dilutive effect of the rights was not triggered by the announcement of a public bid.

The Company’s Board of Directors, acting upon the unanimous recommendation of a special committee of the Board comprised of three disinterested directors (the “Special Committee”), approved the Merger. In reaching its decision, the Special Committee and the Board received a fairness opinion from the Company’s financial advisor, Legg Mason Wood Walker, Incorporated.

Under the Merger Agreement, Socrates’ obligation to consummate the Merger was subject to its ability to obtain financing, and at the time the Merger Agreement was signed, Socrates had received signed commitment letters providing for the necessary debt and equity financing, subject to certain conditions.

In November, 2002, Socrates advised the Special Committee that Socrates did not believe the contemplated merger consideration would be financeable at $7.75 per share. Subsequently, on February 3, 2003, the Company terminated the Merger Agreement, and abandoned the merger and the other transactions contemplated thereby.

During the first nine months ended March 31, 2003, the Company expensed approximately $1,018,000 of legal, professional and other registration fees and expenses incurred in connection with the Merger.

On August 7, 2002, a civil action was commenced in the Court of Chancery in the State of Delaware in New Castle County. The plaintiff in that action sought to represent a putative class consisting of the public stockholders of the Company. Named as defendants in the complaint were the Company, members of the Company’s Board of Directors and one former member of the Company’s Board of Directors. The plaintiff alleged, among other things, that the Merger was unfair and that the Company’s directors breached their fiduciary duties by failing to disclose fully material non-public information related to the value of the Company and by engaging in self-dealing. The complaint sought an injunction, damages and other relief. The Company was served with the complaint on August 22, 2002. A stipulation and dismissal of that case was ordered by the court on February 27, 2003 due to the fact that the Merger Agreement had been terminated.

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Note 4 – Goodwill

The Company adopted SFAS No. 142, Goodwill and Other Intangible Assets, effective July 1, 2001. Under SFAS No. 142, goodwill is no longer amortized but will be assessed for impairment at least annually or upon an adverse change in operations. The annual impairment testing required by SFAS No. 142 requires judgments and estimates and could require the Company to write down the carrying value of its goodwill and other intangible assets in future periods.

The net carrying value of the Company’s goodwill was $48,376,000 as of July 1, 2002. Due to the termination of the Merger Agreement and the decline in the stock price, the Company was required by SFAS 142 to evaluate the Company’s goodwill for recovery based on the facts and circumstances at December 31, 2002. An independent valuation consultant engaged by the Company estimated fair values for each reporting unit using discounted cash flow projections in evaluating and measuring a potential impairment charge. The level one impairment test as required under SFAS 142 as of December 31, 2002 indicated that two of the Company’s ten reporting units were impaired (Washington/Oregon and Pennsylvania/New Jersey). Based on the consultant’s independent valuation and completion of the level two analysis, the Company recorded an impairment loss related to these two reporting units of $2,200,000, which is recorded as a component of income from operations.

Note 5 – Earnings Per Share

Earnings per share are based on the weighted average number of shares and common stock equivalents outstanding during the period. In the calculation of dilutive earnings per share, shares outstanding are adjusted to assume conversion of the Company’s non-interest bearing convertible preferred stock if they are dilutive. In the calculation of basic earnings per share, weighted average number of shares outstanding are used as the denominator. The Company was in a loss position for the nine months ended March 31, 2003. The common stock equivalents of stock options, warrants and convertible securities issued and outstanding at March 31, 2003 were not included in the computation of diluted earnings per share for the nine months then ended as they were antidilutive. Earnings per share are computed as follows (dollars and average common stock outstanding in thousands):

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Note 6. New Accounting Pronouncements

In December 2002, the FASB issued Statement No. 148, “Accounting for Stock-Based Compensation-Transaction and Disclosure, an amendment of FASB Statement 123” (“SFAS 148”). SFAS 148 amends FASB Statement No. 123, Accounting for Stock-Based Compensation, to provide alternative methods of transition for an entity that voluntarily changes to the fair value based method of accounting for stock-based employee compensation. It also amends the disclosure provisions of that Statement to require prominent disclosure about the effects on reported net income of an entity’s accounting policy decisions with respect to stock-based employee compensation. Finally, this Statement amends Accounting Principles Board Opinion No. 28, Interim Financial Reporting, to require disclosure about those effects in interim financial information. SFAS 148 is effective for financial statements for fiscal years ending after December 15, 2002. The Company expects to continue to utilize the intrinsic valuation method for recoding employee stock based compensation.

In April 2002, the FASB issued SFAS 146, “Accounting for Cost Associated with Exit or Disposal Activities”. SFAS 146 establishes guidelines for the recognition and measurement of these cost and is effective as of January 1, 2003.

In February 2003, the Company identified and is now creating a plan to close or sell schools that are under-performing or are in locations that do not fit into the Company’s school cluster concept. Once the plan is finalized it will be reviewed and approved by the Company’s Board of Directors prior to implementation. Accordingly, the Company expects to record a charge in the fourth quarter ending June 30, 2003 related to lease discontinuance, recoverability of certain assets below carrying value and other cost associated with the school closure plan.

Note 7. Discontinued Operations

Effective July 1, 2002, the Company adopted SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets. SFAS No. 144 supersedes SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of and the accounting and reporting provisions of APB No. 30, Reporting the Results of Operations - Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions for the disposal of a segment of business. SFAS 144 modifies the accounting and reporting for long-lived assets to be disposed of by sale and it broadens the presentation of discontinued operations to include more disposal transactions.

During the first quarter of Fiscal 2003, the Company discontinued the operations of a leased school in Sarasota, Florida. In January 2003, the Company entered into a sub-lease agreement for the remaining term of that lease in excess of the future lease payment obligations. Leasehold improvements at this facility having a book value of $657,000 at March 31, 2003 are being retained by the Company and will be depreciated over the remaining term of the lease.

In the second quarter of Fiscal 2003, the Company entered into an agreement to sell an owned school in the greater Phoenix, AZ area and reduced the carrying value of the property to its net realizable value. The sale of the school, subject to financing contingencies, is expected to be consummated in the next six months.

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Both of these schools meet the criteria of discontinued operations in SFAS 144. The operating results for the two schools were classified as discontinued operations in the unaudited statements of operations for all periods presented, net of tax. A summary of discontinued operations is as follows (dollars in thousands):

Operating expenses for the nine months ended March 31, 2003 include impairment charges of $2,460,000. The net realizable value of the owned school of $3,850,000 has been classified as a current asset held for sale at March 31, 2003.

Note 8 – Segment Information

The Company manages its schools based on three geographical regions within the United States. In fiscal year 2000 the Company acquired The Activities Club and began managing charter schools. These operations have different characteristics and are managed separately from the school operations. These operations do not currently meet the quantification criteria and therefore are not deemed reportable under SFAS 131, “Disclosures about Segments of an Enterprise and Related Information” and are reflected in the “other” category.

The table below presents information about the reported operating income of the Company for the nine months and the three months ended March 31, 2003 and 2002 (dollars in thousands):

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Note 9 – Intangible Assets

Intangible assets include non-compete agreements, trademarks and other identifiable intangibles acquired in acquisitions. Such intangibles are being amortized over the life of the intangibles ranging from 3 – 20 years.

At March 31, 2003 and June 30, 2002 the Company’s intangibles assets were as follows (dollars in thousands):

Amortization expense was $258,000 and $368,000 for the nine months ended March 31, 2003 and 2002, respectively.

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Note 10 – Stock Based Compensation

The Company accounts for employee stock options in accordance with APB 25, “Accounting for Stock Issued to Employees” (as amended by SFAS 148, “Accounting for Stock Based Compensation-Transition and Disclosure”). No stock-based employee compensation cost is reflected in net income, as all options granted under the Company’s plans had an exercise price equal to the market value of the underlying common stock on the date of grant.

Because no compensation expense is recognized under APB 25, the Company makes pro forma disclosures of net income (loss) and basic and diluted earnings (loss) per share as if the compensation expense had been recognized based on the fair value of the stock options on the grant date.

To determine the pro forma impact, the fair value of stock options is estimated on the date of grant using the Black-Scholes option-pricing model and is then hypothetically amortized to compensation expense over the three-year vesting period. The pro forma impact for the three months and the nine months ended March 31, 2003 is as follows (dollars in thousands, except per share amounts):